How to report taxes on foreclosed homes

My father-in-law recently received a 1099-A from the bank due to the foreclosure of his home. The home was tagged with a fair market value less than the acquisition cost.

He is concerned that the difference might affect his tax return. What forms should he accomplish so he could reflect the 1099-A he received?

Dear Art,

Your in-law received the form because the bank has acquired his property through foreclosure. Form 1099-A is used to report to the IRS the acquisition of secured (i.e. mortgaged) property by a mortgage lender through foreclosure or other abandonment. The transfer of the property is considered a sale of the property to the mortgage lender for the amount of the debt. For illustration purposes, we'll call this abandonment.

In a foreclosure there are usually two steps, the abandonment and then the mortgage lender sale. Usually, the abandonment of a personal residence does not have an immediate tax implication and there is nothing to report on your in-law's individual tax return for the year of the abandonment.

There would only be a tax impact if the loan was without recourse against the borrower or if it was business or investment property. Most conventional mortgages are written with the personal guarantee of the borrower so the abandonment does not result in income.

When the property is sold, the mortgage lender may attempt to collect the shortfall in the mortgage loan from the borrower. If the lender cannot collect the debt, it will cancel it and issue a 1099-C to the borrower.

In most cases, if the property involved was the borrower's personal residence, there will be no tax impact as a result of the cancellation of the debt. Generally, the borrower will only have a tax impact if the canceled debt exceeds their cost in the property. This usually happens if the borrower did a mortgage refinance and cashed out funds that were not used to improve the property. Publication 4681 discusses foreclosures and its tax consequences.

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.

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